Barnes & Noble shares soar on Microsoft deal

Analysts applaud Nook digital venture, but say challenges remain

By

AndriaCheng

PolyaLesova

NEW YORK (MarketWatch) — Shares of Barnes & Noble Inc. jumped 70% on Monday after the bookstore operator’s technology partnership with Microsoft Corp. boosted its coffers and put it in a potentially better position to compete against rivals such as Amazon.com Inc. and Apple Inc.

Barnes & Noble said the new unit will still have a close relationship with the company’s 700 retail bookstores. Barnes & Noble, which has annual sales of about $7 billion, also operates about 641 college bookstores.

The new venture will produce a Nook reading application for Windows 8 that offers eBooks, magazines and newspapers to customers in the U.S. and abroad. Barnes & Noble Chief Executive William Lynch said on a conference call that the New York-based company doesn’t have any Nook exposure outside of the U.S.

“This is a mutually beneficial partnership,” said Janney Capital Markets analyst David Strasser. “Microsoft makes a major move in building out its ecosystem by acquiring necessary hardware and [Barnes & Noble] gets access to being the major player on Windows 8. It also puts to rest concerns about a lack of capital to compete with [Amazon].”

Strasser said Microsoft’s investment assigns Barnes & Noble’s college and Nook business a much higher valuation than Liberty Media
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did a year ago, when the QVC parent offered to buy Barnes & Noble for $17 a share, or about $1 billion based on the company’s shares outstanding.

“We are very pleased,” said Michael Glickstein, chief investment officer of G Asset Management, in an interview. “We are very confident that this partnership will create value. It will lead to great things for all shareholders.”

G Asset Management, which counts Barnes & Noble as the private investment firm’s biggest holding, in March offered $460 million to buy 51% stake of the college bookstore business. Glickstein said Monday that the firm is no longer focused on its offer following the latest announcement. He said the Microsoft deal values Barnes & Noble in excess of $30 a share. G Asset held 236,475 shares, or a 0.4% stake of Barnes & Noble, as of February, according to FactSet Research.

Barnes & Noble, which said in January it was considering the separation of its digital business, said Monday it intends to explore all alternatives for how a strategic separation of the new unit may occur, though it said there’s no assurance that the review would lead to the creation of a stand-alone public company.

‘Jury still out’

Some analysts said while the partnership is a step in the right direction, Barnes & Noble still faces the same competitive challenges.

The company is expected to report its second straight year of operating losses, with another loss projected for the new fiscal year, amid increased investment on the Nook franchise, Morningstar analyst Pete Wahlstrom told MarketWatch. Meanwhile, the company’s Nook business growth rate also has slowed, he said.

“The jury is still out as to how they can monetize this,” Wahlstrom said. “With Microsoft, it has a much larger and substantially larger and financially more stable partner. It gives them some room, but there’s still very still competition in the market place.”

Even internationally, the analyst said Amazon, Apple and Google also are making their own push.

There are still concerns as to what would happen to Barnes & Noble’s still profitable retail business if the digital side is separated.

The partnership wouldn’t undermine the “symbiotic relationship” the unit has with the company’s retail operations, Lynch said on the call.

He added the college business is also an important component of the new subsidiary, which will push for the distribution and management of digital education materials.

“The shift to digital is putting the world’s libraries and newsstands in the palm of every person’s hand, and is the beginning of a journey that will impact how people read, interact with, and enjoy new forms of content,” said Microsoft President Andy Lees, adding that electronic books are expected to represent over a third of books sold over the next few years.

“Our complementary assets will accelerate e-reading innovation across a broad range of Windows devices, enabling people to not just read stories, but to be part of them. We’re on the cusp of a revolution in reading,” Lees said.

The two companies also said they have settled their patent litigation. Barnes & Noble and the new unit will have a royalty-bearing license under Microsoft’s patents for its Nook and tablet products.

“All-in, we view the agreement as a highly positive near-term catalyst for Barnes & Noble’s equity valuation although the terms of the agreement suggest that the company continues to bear significant responsibility for the ultimate success of the digital business,” said Barclays Capital analyst Alan Rifkin. This agreement does “provide the Nook business with greater ability to compete more effectively against Amazon’s Kindle, it does not alter the unprofitable dynamics of the E-reader business.”

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